CCP Congress: China’s foreign investors are out. We stay.
03 November 2022
After the strong selloff in the Chinese equity market that followed the end of the CCP congress, we reviewed the situation with our local partner, helping us shape our investment decisions by integrating the Chinese point of view.
Xi Jinping has officially secured his third five-year term as the Party head. He consolidated his power with the four new members of the top policymaking circle, the Politburo Standing Committee (PSC). These new members have previously worked with President Xi and are believed to be his close allies. Investors believe that more state control and lack of dissent will result in more likely policy failures, adding uncertainty.
Impact on our Investment Case
Foreign investors turned net sellers
The day after the end of the 20th CCP Congress, the Chinese market crashed. Foreign investors became more concerned by the absence of balance in the Party's head and sold that day for more than $2.5bn of stocks. Despite the relatively good macroeconomic data released minutes after Congress, the equity market sold off. This was especially true for giant Chinese companies, the ones preferred by foreign investors and used as a proxy to be exposed to the Chinese economy. However, we found no fundamental reasons to justify finishing the day with the worst performance on the Hang Seng since 2008.
The strengthening of Xi's power implies a more significant shift towards state control and a less market-driven economy. This scared foreign investors, who were not used to the Chinese way. For example, the Report of the 20th CCP Congress reaffirmed that the CCP would enhance China's "socialist market economy".
Net flows from foreign investors have turned negative for 2022, which will not support an already low allocation to the second-largest economy in the world.
Providing the means to match up the goals
While U.S.-China tensions are not new and have never stopped, it remains a source of concern for foreign investors. By reinforcing his power, Xi is sending a clear signal to the U.S.: he has more authority than ever and firmly controls the Communist Party. The geopolitical playbook is becoming more and more critical. Thus, the U.S. cannot silently influence other Chinese policymakers, and nothing can happen without Xi's consent. The U.S., irrespective of the Party in charge, continues to see China as a soft enemy to be fought, whether through the tariffs, the crackdown on Chinese biotechs, the recent export control of semis to China, or even its military movements and training in South East Asia.
However, with a consolidated government and a loyal team, Xi has the full power and capacity to continue his key reforms. In parallel to the stabilization of household income (a vital component of the "common prosperity"), Chinese policies also focus on security (in agriculture, supply chain, energy, information, and defense).
More meaningful for us, the Report of the 20th CCP Congress reiterated its willingness to promote technology and innovation. Dual circulation, green economy, and common prosperity remain keywords, confirming their 14th five-year plan exposed in late 2020. Investors need to follow the government. A Western saying goes: Don't fight the Fed. The Chinese version goes: Don't fight the CCP.
Around March 2023, an upcoming wave of retirements and promotions will reshuffle many key central government posts. Until then, we believe the Chinese government will be unlikely to surprise. But, after the reshuffling, economic development for common prosperity will be the government's top agenda. Companies, particularly the ones with ties to the government and engaging in a common prosperity, will eventually benefit under this Xi-strengthened government.
We see the exit from current restrictive Covid measures, along with some stimulus from the fiscal or monetary side, as a crucial driver for a growth recovery in China. Thus increasing exposure to China for the medium to long term must be seriously considered.
While we do not expect political surprises in China until the second quarter of 2023, fragility remains across all equity markets. A strong USD, a likely U.S. recession, and increasing trade tensions may impact China’s economy as well, notably in the form of fewer exports. Investing in China remains challenging, especially from our Western-oriented point of view. The long-term view of Chinese policymakers is misunderstood, and investing in China requires following their view.
We believe the recent sell-off is disconnected from fundamentals and offers investors an opportunity to diversify and benefit from Chinese growth. Given the relatively low level of the equity market and the Yuan, it might not be unreasonable to increase the strategic exposure of portfolios to China for the next five years. Nevertheless, correct stock picking remains crucial.
At Atonra, our expertise and historical sectors are the same ones privileged by Xi Jinping. Technology, renewable energy, and healthcare, given the aging population, are the three pillars of the future of the Chinese economy to achieve common prosperity. We use our in-house scientific-based expertise and the support of our local partner to select Chinese companies able to thrive in this challenging market.
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